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Are the Big Six suppliers losing their grip on the UK energy market?

Just six energy suppliers monopolised the UK energy market after the gas and electricity networks were privatised, but over 60 smaller rivals have since emerged as effective competition. Is the stranglehold of the Big Six energy suppliers coming undone?

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EDF Energy
Source: Bloomberg

The UK energy network explained: generation, transmission and distribution

There are multiple cogs operating together to keep the gas and electricity networks going. The UK gas network was privatised in 1986 and the electricity network followed suit soon after in 1990, allowing households to choose suppliers.

Major power plants are connected to a central transmission system that transports high-voltage electricity to smaller distribution networks, which lower the voltage and deliver the power to homes and businesses.

National Grid plays a unique role by operating this central transmission system in England and Wales, and is responsible for balancing supply and demand of electricity in the market. The transmission network over central and southern Scotland is operated by Iberdrola, with the rest of Scotland being served by SSE

There are eight distribution networks delivering electricity to the end user, which are ultimately owned by companies including (but not limited to) SSE, Iberdrola, PPL Corp, and Berkshire Hathaway Energy.

National Grid is also the operator of the gas transmission system that transports gas to eight regional distribution networks, one of which it also partly operates. The other distribution networks are backed by the likes of sovereign wealth funds and investment trusts. 

Who are the Big Six energy suppliers in the UK?

Big Six Parent company Glance at parent company activities

British Gas

Centrica

  • Supplies energy in UK, Ireland, US
  • Trades and distributes energy
  • Energy exploration and production
  • Connected home and energy storage

SSE

SSE

  • Supplies energy in UK and Ireland
  • Has transmission and distribution networks
  • Generates energy and sells wholesale
  • Energy storage, broadband, telephone

EDF Energy

EDF SA (84% owned by French government)

  • Generates energy, mainly nuclear
  • Supplies energy in UK, France, Belgium, Italy

 

EON

EON SE

  • Generates, distributes, trades and supplies energy in numerous markets spread over the UK, France, Germany, Czech Republic, Hungary, Italy and others

npower

RWE Group

  • Generates and trades energy in Europe
  • Supplies energy in UK, Germany, Belgium
  • Netherlands, Czech Republic, Hungary, Poland and others

ScottishPower

Iberdrola

  • Supplies energy in UK and Spain
  • Generates energy worldwide
  • Network operator in UK, Spain and US

 

The Big Six energy suppliers to become the Big Five

In response to the changing environment, SSE and npower are currently merging their retail energy supply arms to create a new listed company, two-thirds of which will be owned by SSE. A name is yet to be decided.

The changing landscape of the UK energy market

The rate of change in the UK energy market has accelerated over the last couple of years and the sector has drawn criticism from both the Conservative government and the opposition Labour party, the latter of which has threatened to renationalise the industry along with other industries like water and rail.

The most significant change has been the government’s draft bill to introduce a temporary price cap on standard variable tariffs, the most popular option in the market and the option which around 60% of households find themselves on. The tariffs have been criticised, as they often have no end date and, on average, are more expensive than shorter fixed-term tariffs.

The price cap is expected to come in before winter 2018, but the exact details are yet to be decided, leaving some major uncertainty in the market. The cap will run until 2020, when Ofgem will make recommendations as to whether a cap should continue after that.

The heavy scrutiny of standard variable tariffs has been one of the issues to plague the Big Six, while having less of an impact on smaller suppliers. This is because they hold the most amount of these tariffs on their books. In September, a huge 71% of SSE’s domestic accounts were on standard variable tariffs, followed by British Gas at 67%, EON at 61%, EDF at 52%, npower at 48% and ScottishPower at 41%.

There are a number of other policies that Ofgem has recently introduced that impact the UK energy market, including but not limited to:

  1. Proposed reducing the amount distribution network operators can pay their shareholders to 3% in 2021 from the current 5% limit, lowering the cost of equity for operators which include SSE and National Grid
  2. Banning suppliers from backbilling customers for energy that was used over 12 months ago
  3. Extending a safeguard tariff to millions of accounts held by vulnerable customers
  4. The roll-out of smart meters to the majority of UK homes by 2020

All of these changes have culminated since Ofgem referred the UK energy market to the Competition & Markets Authority back in 2014, which was followed by the most comprehensive investigation into the market being carried out since it was privatised, introducing over 30 new measures.

Small suppliers loosen Big Six’s grip on the market: UK energy market share

The Big Six held 99% of the domestic supply market in the final quarter of 2012, but that has fallen to 80% over the last five years, as over 60 rival suppliers have emerged. Collectively, these small suppliers have poached a large chunk of market share from their larger rivals, but only a few have managed to carve out a sizeable portion of the market for themselves.

The most intriguing rival that has emerged is First Utility, which was already leading the race among smaller suppliers, before acquiring even more firepower after Royal Dutch Shell snapped up the company late last year, which should unnerve its larger rivals and represents another significant change in the market amid the SSE-npower deal.

Utility Warehouse, owned by Telecom Plus, has managed to carve out and keep its 2% share of the market over the last five years, while Green Star Energy is a division of Just Energy Group.

As well as providing competition in terms of pricing, smaller suppliers have been able to win over consumers by tapping in to the dissatisfaction that consumers have become accustomed to receiving from the Big Six, such as poor customer service. Many have created unique selling points by providing a niche service to the market, such as solely providing prepaid energy or only supplying 100% renewable energy to cater for greener consumer trends.

All of the Big Six have lost market share in the domestic supply market

  Start of 2004 Start of 2018
British Gas 24% 21%
SSE 15% 14%
EON 21% 13%
EDF Energy 13% 12%
npower 15% 10%
Scottish Power 11% 10%

 

However, with so many smaller suppliers entering the market and competing for the fifth of the market not monopolised by the Big Six, many of them have fallen by the wayside, leaving hundreds of thousands of customers without a supplier.

However when a supplier does go bust, Ofgem steps in to transfer over all the accounts to a new supplier. Much like the effect of collective switching, this can provide smaller suppliers with a swoon of new accounts when a rival goes bankrupt. One of the biggest suppliers to have fallen from grace was GB Energy in 2016, when 160,000 customers were moved over to Co-Operative Energy.

Small energy suppliers are still more vulnerable than larger rivals

Larger suppliers are having to implement bigger changes in response to heightened competition and the rapidly-changing environment, but smaller suppliers are still highly vulnerable in ways the Big Six are not – and a lot of it is because they lack the scale or the generation capabilities of the Big Six. Others have been dogged by poor customer service or by a lack of billing and online infrastructure.

With fixed-rate tariffs becoming increasingly popular over the heavily criticised standard variable tariffs that the majority of UK households are on, the margins that smaller suppliers can come under threat when wholesale prices rise, for example. This also impacts their ability to compete as effectively when it comes to freezing prices.

One example was demonstrated by David Bird, the chief executive of Co-operative Energy, who said in October last year that the price cap on variable tariffs could see ‘unintended consequences’, such as forcing firms to take drastic action like moving jobs abroad in order to maintain margins and cut costs.

Are the large energy suppliers losing share because more customers are switching accounts?

Ofgem and the government have taken steps to encourage as many UK households to switch energy accounts in order to find a better deal, including introducing measures to make it easier to move from one supplier to another – although switching is still one of the four key things customers complain about the most, in addition to customer service, billing and metering.

Collective switching has been one of the more significant developments in the market, where large groups of customer accounts are moved in one go. There are a number of schemes that have popped up, that pool together large volumes of accounts in order to hold a better bargaining position with suppliers, to therefore achieve a better deal for households than would otherwise be possible for an individual household moving supplier.

Still, there is a misconception that more UK households have started to switch energy suppliers since the market opened up to smaller companies.

Between 2007 and 2009, when the Big Six virtually controlled the entire market, over 5 million households were switching their electricity supplier on an annual basis, with around 4 million changing gas suppliers. Importantly, all these switches were being made from one of the dominant players to another.

Between 2010 (when competition began to heat up in the market) and 2016, switching levels of both gas and electricity have remained considerably lower than before the entrance of smaller rivals. On average, 4.4 million households changed their electricity supplier annually over the six year period, while 3.2 million switched their gas.

The change has come in how customers are switching, with more and more leaving larger suppliers for small and mid-sized ones, with a lower proportion moving from one Big Six member to another.

However, there are concerns that those customers currently switching are savvy shoppers seeking a new deal as their contracts run out, rather than those on the most expensive deals that have the most to save by switching accounts.

A measure has been recently outlined by Ofgem to tackle the issue, and break the two-tiered system between the Big Six and smaller suppliers, which has been one of the reasons why the industry keeps finding itself under the spotlight and facing pressure from the government. The idea is to force the Big Six to pass on details of customers that fail to switch supplier after a certain period of time, allowing rivals to approach them and make an offer to entice customers to switch, with one of the Big Six already reportedly passing on 50,000 customers who have not switched for at least three years.

How have the Big Six energy suppliers performed?

The Big Six suppliers make their profit from three core areas:

  1. Supplying energy to residents 
  2. Supplying energy to business and industry 
  3. Generating energy

On average, generating electricity has proven to be the most lucrative activity, but profits have dwindled in recent years to see a more balanced profit ratio between residential supply and power generation. 

However, this picture is too generalised, as each company performs very differently in each activity, with some like EDF Energy deriving the majority of their earnings from generating power whilst others like Centrica rely more on their energy supply units.

The total value to the market of selling electricity and gas to UK households in 2016 was £28 billion, which can be compared to the value of selling energy to industrial sectors of £8.5 billion and the value of supplying energy to the commercial, transport, agricultural, public and other sectors of £13.4 billion.

However, the profitability of supplying energy varies depending on the sector being supplied. The value of selling electricity and gas to the domestic UK market fell annually over the three years to 2016 on a per kilowatt hour basis, while the rates covering the industrial, commercial and other sectors remained fairly stable.

Average net selling value per kWh in 2016

 

Pence per kWh

Supplying domestic electricity

14.028p

Supplying industrial electricity

8.07p

Supplying commercial and other electricity

11.635p

Supplying domestic gas

4.162p

Supplying industrial gas

1.641p

Supplying commercial and other gas

2.446p

 

Earnings from generating energy

One of the primary reasons that each of the larger suppliers puts in such a varied performance when it comes to generating energy is because of the different fuels each of them use, as the likes of coal, nuclear, gas and renewables are all priced differently and carry different levels of profitability, which over time can shift around, as government policy and public attitudes change.

  Coal Gas Nuclear Renewable Other
British Gas 11% 35% 10% 40% 4%
SSE 9% 56% 5% 27% 3%
EDF Energy 6% 8% 77% 9% 0%
EON 14% 41% 11% 29% 5%
ScottishPower 7% 57% 6% 28% 2%
npower 1% 90% 1% 7% 1%
UK Average 9% 44% 21% 24% 2%

 

EDF Energy generates market leading profits from generating power to the UK mainly because of its nuclear capabilities, demonstrated by the likes of Hinkley Point. However, profits have fallen over the years and SSE, the only other to deliver consistent profit from its operations, has caught up.

While the cost of energy for UK households often draws criticism of energy companies, the majority of domestic bills are made up of costs that suppliers have limited control over. On average, the Big Six made just £53 worth of earnings from a domestic bill of £1123 in 2016, just 4.7% of the total.

There is another substantial player within this market. Drax Group operates the largest renewable power plant in the country, after converting three of its six units to burn wood pellet biomass rather than coal. The plant feeds about 7% of the nation’s total electricity demand and represents about 17% of all renewable energy generation. It also supplies businesses in the UK through Haven Power and Opus Energy, but does not feed energy to residential customers.

Earnings from supplying energy

All of the Big Six have been shedding customer accounts over the past few years, as they cede market share.

Taking the two London-listed firms, Centrica experienced a sharp 13% decline in domestic energy account numbers over the four years to the end of 2017, losing 1.9 million customers, while SSE saw a 14% drop between March 2014 and March 2017 after losing 1.1 million customers.

The profitability of Centrica’s domestic supply arm in the UK is market leading, while EON’s profits have been steadily growing. Meanwhile, SSE has also delivered earnings that match the consistency and reliability of its generation arm, making it the best overall performer.

What other listed energy companies are there?

There are other publicly listed players within the UK energy market that investors can use to gain direct exposure to some of the smaller companies making headway in the market.

Good Energy’s selling point is that it only supplies customers with renewable energy, and the company is currently profitable, following a focus on maintaining margins in light of aggressive competition. The company is also growing its power generation capabilities and moving into other areas in preparation for growth in areas like electric vehicles.

Plutus Powergen offers investors a slightly different proposition, as its primary operations are small-sized power plants which are used to provide backup power at quick notice when other power supply in the network is running low.

The sites are primarily powered by diesel generators, and the firm is paid to keep them on standby and bring them quickly online when there are power shortfalls. While the country has welcomed the growing proportion of energy being generated from renewable sources, this has caused higher levels of intermittence in the network. The technology to store renewable energy, so it can be used when the wind isn’t blowing or the sun isn’t shining, has not yet matured.

Investors can also look at Jersey Electricity, an AIM-listed firm that is the sole supplier of electricity on the island of Jersey that imports, generates, transmits, and distributes power.

Conclusion

Overall, there are fundamental changes occurring in the UK energy market. The price cap represents the biggest government intervention since privatisation, and regulatory pressure is likely to remain high for the foreseeable future.

Meanwhile, the industry is dealing with other changing trends, such as the move toward renewable energy which is placing more importance on distribution networks as smaller scale power plants become more common and continue to bypass the transmission network. This is also opening up growth areas like energy storage.

Although the Big Six gain advantages from their scale and balanced portfolios, it is down to them to stem customer losses and fend off the growing threat of smaller suppliers, who are in turn having to carve out unique positions in the markets with new offerings while building businesses that can last.

The Big Six will continue to lose customers to smaller suppliers, at least in the short term, and there will be more small suppliers that will succumb to high competition in the market and continue to struggle with fluctuating wholesale prices and scaling up their companies.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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